Three control tests

A CFC is a non-resident company that satisfies one of three control tests. Whether a company is a resident of a foreign country is determined according to Australian tax law as modified by double-taxation agreements with other countries.

The three control tests are the:

strict control test

assumed controller test

de facto control test.

Strict control test

A foreign company will be treated as a CFC under the strict control test if a group of five or fewer Australian ‘1% entities’, together with their associates, owns or is entitled to acquire a control interest of at least 50% in the foreign company.

An Australian 1% entity is an Australian entity that, together with its associates, holds an interest of at least 1% in the foreign company.

An Australian entity is an Australian partnership, an Australian trust, or an entity (other than a partnership or trust) that is a Part X Australian resident. A Part X Australian resident is a resident of Australia who is not treated solely as a resident of another country under a double-taxation agreement between Australia and that country.

The associate-inclusive control interest of an entity is the sum of interests held by the entity and its associates in the foreign company. Interests that the entity and its associates are entitled to acquire are also taken into account.

Example 1Strict control test

This test will be satisfied if three Australian residents each hold interests of 30%, 10% and 10% respectively in a foreign company.

End of example

Assumed controller test

A foreign company will normally be treated as a CFC under the assumed controller test if a single Australian entity owns, or is entitled to acquire, an associate-inclusive control interest of at least 40% in the foreign company. An entity's associate-inclusive control interest in a foreign company is the sum of the interests held in the company by the entity and the associates of the entity. However, a foreign company will not be treated as a CFC under the assumed controller test if the company is controlled by a party or parties unrelated to the single resident or its associates.

Example 2Assumed controller test

If an Australian entity holds 45% of the interests in a foreign company and the remaining 55% is held by several non-residents, it would be assumed under this test that the Australian entity controls the foreign company.

End of example

De facto control test

A foreign company will be treated as a CFC under the de facto control test if a group of five or fewer Australian entities, either alone or with associates, effectively controls the foreign company.

Example 3De facto control test

If an Australian entity can control the appointment of the directors of a foreign company, the Australian entity will generally be taken to have de facto control of that foreign company.

End of example

When is control measured?

A statutory accounting period of a CFC is a period of 12 months ending 30 June, unless the CFC makes an election to use another period. The control test is applied at the end of a CFC's statutory accounting period to check whether income of the CFC is to be attributed.

It may also be necessary to measure control at the time a CFC pays a dividend to another CFC or to a controlled foreign trust or at the time a CFC changes residence.

Election to change a CFC's statutory accounting period

A CFC can make an election to change its statutory accounting period only if the accounting period is:

regularly used by the CFC for complying with the tax law of a foreign country, or

regularly used by the CFC for reporting to its shareholders.

A CFC may also make a written election, and send it to the ATO, to adopt a statutory accounting period ending on a date other than 30 June if the period is regularly used for complying with the tax laws of the CFC's country of residence or is regularly used for reporting to the CFC's shareholders. You may make this election on behalf of a wholly owned CFC.

A CFC may subsequently elect another statutory accounting period ending on any date, including 30 June, provided the above conditions are satisfied.

Where a CFC chooses another statutory accounting period, it must complete the current statutory accounting period. The intervening statutory accounting period – that is, from the last day of the current period to the beginning of the new period – will be less than 12 months. The new and subsequent statutory accounting periods will be 12 months.

Example 4Statutory accounting periods

If a company with a statutory accounting period ending 30 June 2002 elected on 30 August 2001 to change to a statutory account period ending 30 September, it would have statutory accounting periods of:

1 July 2001 to 30 June 2002

1 July 2002 to 30 September 2002

1 October 2002 to 30 September 2003, and

subsequent 12-month statutory accounting periods ending 30 September.

It is not necessary for a CFC to complete the current statutory accounting period before beginning a new period if the election is made when the CFC first comes into existence or when a company first becomes a CFC.

End of example

What interests in a foreign company are taken into account in the control tests?

In most cases, an interest in a foreign company will be held in the form of shares. This interest can be held either directly or indirectly through other entities. At a particular time, your interests in a foreign company include the interests you hold in the company, as well as the interests you are entitled to acquire.

The interests of your associates in a foreign company are also relevant for determining whether you have an interest in the company.

Direct control interest in a foreign company

Your direct control interest in a foreign company is the largest of the percentages that you hold, or are entitled to acquire, of the following:

total paid-up share capital in the foreign company

total rights to vote, or to participate in any decision making, in relation to

the distributions of capital or profits

the changing of constituent documents

the varying of share capital of the company

total rights to distributions of capital or profits of the company on winding up

total rights to distributions of capital or profits of the company other than on winding up.

Example 5Direct control interest in a foreign company

A foreign company is established issuing 100 ordinary shares. An Australian taxpayer purchases 50 of these shares, which entitle the taxpayer to 50% of the income, voting and capital rights of the company. The direct control interest of the Australian taxpayer in the foreign company is 50%.

End of example

Example 6Direct control interest in a foreign company where shares confer different rights

An Australian company has a 50% voting interest and a 75% income interest in a foreign company. The direct control interest of the Australian company in the foreign company is 75%.

End of example

How is a direct control interest measured if the test time occurs before the end of an accounting period?

A taxpayer's direct control interest in a company has to be measured at a point in time, referred to as the test time.

However, in some cases, it may not be possible to measure the percentage a taxpayer holds of the total rights to the profits of a company, or to a distribution of capital on winding up of the company, before the end of the accounting period of the company.

For example, this would be the case if some shareholders are entitled to a fixed return of capital or profits.

In these cases, the taxpayer's rights to capital or profits are measured at the end of the accounting period of the company. It is assumed for this purpose that the rights held by the taxpayer at the test time are held at the end of the accounting period of the company.

Exclusion of eligible finance shares

Eligible finance shares are not taken into account in working out an entity's direct control interest in a company. Broadly, these are shares issued under preference share financing arrangements with Australian financial intermediaries (for example, banks) and their subsidiaries. In effect, the shares are issued in place of loans.

Indirect control interest in a company

A taxpayer may hold a direct control interest in an entity (Entity A) which holds a direct control interest in another entity (Entity B). In this case, the taxpayer has an indirect control interest in Entity B.

A taxpayer's indirect control interest in Entity B is obtained by multiplying the direct control interest of the taxpayer in Entity A by the entity's direct control interest in Entity B.

This process of multiplication is continued where there are further entities in the chain.

Indirect control interest may only be traced through a controlled foreign entity

An indirect control interest in a foreign entity can be traced only through controlled foreign entities (CFEs). These are CFCs, controlled foreign partnerships and controlled foreign trusts.

A controlled foreign partnership is a partnership which does not have a resident partner and has at least one CFC or a controlled foreign trust as a partner. A controlled foreign trust is a trust, other than an Australian trust:

where five or fewer residents and their associates hold, or are entitled to acquire, 50% or more of the income or capital of the trust.

Deeming rules for tracing an indirect control interest

For determining the indirect control interest in an entity (but not for working out the amount of the income to be attributed to a taxpayer) a resident or an interposed CFC is deemed, in the following specified circumstances, to own a 100% interest in a lower-tier entity.

The control tracing interest of an entity will be treated as 100% if, together with associates, the entity:

has an interest of at least 50% in a foreign company

satisfies the assumed controller test in relation to a foreign company

actually controls the foreign company

is a partner in a partnership that is not an Australian partnership

is an eligible transferor in relation to a trust, or

has an interest of at least 50% in a trust that is not an Australian trust.

Example 7Indirect control interest

A resident company holds a 60% interest in a foreign company, FC1, which holds a 35% interest in another foreign company, FC2. FC2 holds a 60% interest in foreign company FC3. Another resident holds a 20% interest in FC2.

The indirect control interest of the resident company in FC3 is:

Resident company

Direct control interest%

Control tracinginterest%

FC1

60

100

FC2

35

35

FC3

60

100

The indirect control interest of the resident company in FC3 is worked out as follows:

100% x 35% x 100% = 35%

It is possible to trace interests through FC2 because it is a CFC. FC3 is also a CFC because the resident company has an indirect control interest of 35% in FC3 and another resident has an indirect control interest of 20% in FC3 (that is, 20% in FC2 x 100% interest for tracing control of FC2 in FC3).

End of example

Associate-inclusive control interest

Your associate-inclusive control interest in a foreign company is the sum of:

your direct control interests in the foreign company

your indirect control interests in the foreign company

the direct and indirect control interests of your associates in the foreign company.

To avoid double counting, an indirect control interest is not taken into account when determining a direct control interest or another indirect control interest.

If you have an interest in a CFC, you must determine if you are an attributable taxpayer. You are only required to include an amount of attributable income from a CFC in your assessable income if you are an attributable taxpayer in relation to the CFC.

You will be an attributable taxpayer if:

you have an associate-inclusive control interest of 10% or more in a CFC, or

all of the following rules apply:

the CFC is a CFC because of the application of the de facto control test

you are an Australian 1% entity, and

you are part of a group of five or fewer Australian entities who, alone or with associates (regardless of whether the associates are Australian entities) controls the CFC.

What share of the attributable income of a CFC must you include in your assessable income?

If you are an attributable taxpayer, you may be attributed a share of a CFC's attributable income. Your share is called an attribution percentage and is based on your rights to profits from the CFC.

Working out your attribution percentage

Your attribution percentage in a CFC is the sum of your:

direct attribution interest in the CFC, and

indirect attribution interests in the CFC.

The interests of your associates are not included.

Direct attribution interest in a CFC

Your direct attribution interest in a CFC is the largest of the percentages that you hold, or are entitled to acquire, of the following:

total paid-up share capital in the CFC

total rights to vote, or to participate in any decision making, in relation to

the distributions of capital or profits

changing of constituent documents

varying of share capital of the CFC

total rights to distributions of capital or profits of the CFC on winding up

total rights to distributions of capital or profits of the CFC other than on winding up.

Test time

Your direct attribution interest in a CFC is measured at a point in time called a test time. The test time may occur during the accounting period of a CFC.

In some cases, it may not be possible to measure the percentage you hold of the total rights to the profits of a company or to a distribution of capital on winding up of the company before the end of the company's accounting period.

In these cases, your rights to capital or profits are measured at the end of the accounting period of the company. It is assumed for this purpose that the rights you held at the test time are held at the end of the company's accounting period.

Exclusion of eligible finance shares

In working out your direct attribution interest in a CFC, eligible finance shares in the CFC are not taken into account.

Exclusion of real estate investment trust shares

Real estate investment trust shares are not taken into account in working out an entity’s direct attribution interest in a United States real estate investment trust that derives income or holds assets principally in the United States. Control interests held through a United States real estate investment trust will still be taken into account in determining whether a subsidiary of the trust qualifies as a CFC. This will attribute income from a real estate investment trust subsidiary where a taxpayer has a direct interest in the subsidiary.

This exemption applies to statutory accounting periods of CFCs ending on or after 2 July 1998.

Indirect attribution interest in a CFC

You may hold an attribution tracing interest in an entity (Entity A) which holds an attribution tracing interest in another entity (Entity B).

This process of multiplication is continued where there are further CFEs in the chain of entities.

Attribution tracing interests in a CFC

Your attribution tracing interest in a CFC is equal to your direct attribution interest in the CFC. The deemed 100% rule for tracing control does not apply when tracing your attribution percentage.

Attribution tracing interest in a controlled foreign partnership

The attribution tracing interest of a partner in a partnership is the percentage the partner holds, or is entitled to acquire, of the profits of the partnership or of the partnership property. Where the two percentages differ, the attribution tracing interest will be the greater of those percentages.

Attribution tracing interest in a controlled foreign trust

The attribution tracing interest that a beneficiary of a trust holds in the trust is the percentage of the income or property of the trust representing the share of the income or property to which the beneficiary is entitled, or is entitled to acquire. If the percentage of the income and the percentage of the property differ, the higher percentage is treated as the attribution tracing interest.

An eligible transferor has an attribution tracing interest in the controlled foreign trust equal to 100%. See part 1 of chapter 2 to determine whether you are an eligible transferor.

Reduction of the attribution percentage where the total percentage is more than 100%

In some cases, the total of the attribution percentage of all attributable taxpayers may be more than 100%. In these cases, the aggregate is reduced to 100% by reducing proportionately the interest of each attributable taxpayer.

Example 8Reduction where attribution percentage is more than 100%

A foreign company has two classes of shares on issue. Class A carries the right to vote, but no income rights. Class B carries the right to income and is non-voting. An Australian resident (Res1) owns 25% of the Class A shares and 75% of the Class B shares. Another resident (Res2) owns the remaining shares in each class. The foreign company is a CFC and both residents are attributable taxpayers.

Res1's attribution percentage(greater of 25% and 75% )

75%

Res2's attribution percentage(greater of 75% and 25% )

75%

Total interest of residents

150%

Each attributable taxpayer's attribution percentage is reduced in proportion, so that the aggregate interests of all attributable taxpayers is 100%.

A number of exemptions from accruals taxation are provided for amounts taxed in a comparable tax country listed in the Income Tax Regulations 1936.

The countries listed in attachment A of appendix 1 are called listed countries. The countries not listed are called unlisted countries. (A subset of unlisted countries is ‘section 404 countries’).

Summary of terms used to refer to countries

Listed countries

Listed countries are those listed in Schedule 10 of the Income Tax Regulations 1936. Amounts taxed at full rates by listed countries are generally exempt from accruals taxation.

Unlisted countries

Unlisted countries are those that are not listed countries. This includes section 404 countries for all purposes of the CFC rules except the application of section 404.

Section 404 countries

Section 404 countries are those listed as ‘section 404 countries’ in Schedule 10 of the Income Tax Regulations 1936. The list of section 404 countries is in attachment A of appendix 1.

Section 404 excludes from attributable income dividends paid from a company resident in a listed country or section 404 country to a CFC that is also resident in a listed or section 404 country.

When is a CFC a resident of a listed country?

A CFC is treated as a resident of a listed country if:

the CFC is not a Part X Australian resident, and

the CFC is treated as a resident of a listed country under the tax laws of that country.

When is a CFC a resident of a section 404 country?

A CFC is a resident of a section 404 country if:

the CFC is not a Part X Australian resident

the CFC is treated as a resident of a section 404 country under the tax laws of that country, and

the CFC is not treated as a resident of a listed country at that time for the purposes of the tax law of the listed country.

When is a company a resident of an unlisted country?

A company is treated as a resident of an unlisted country if the company is neither a Part X Australian resident nor a resident of a listed country.

Rules that determine the particular unlisted country of residence

In some cases, it is necessary to determine whether a company is treated as a resident of a particular unlisted country, for example, for determining the active income test.

A company is treated as a resident of a particular unlisted country if:

the company is treated as a resident under a tax law of the unlisted country, and

the company is not treated as a resident of any other unlisted country under the tax law of that country.

If a company is treated as a resident of more than one unlisted country under the tax laws of those countries and is incorporated in one of those countries, it is treated as a resident in the country of incorporation.

If a company is not treated as a resident under the tax law of any unlisted country, it will be a resident of the unlisted country in which its management and control is solely or principally located.

If a company is not treated as a resident under the tax law of any unlisted country and does not have its central management and control solely or principally in an unlisted country, it will be a resident of the unlisted country in which it is incorporated.

If the answer to both of these questions is yes, the next step is to determine whether you must include an amount in your assessable income.

Attribution on change of residence

If you were an attributable taxpayer of a CFC resident in an unlisted country and the CFC changed its residence to a listed country or to Australia while you were an attributable taxpayer, you may be subject to attribution on your share of the accumulated profits of the CFC.

Attribution of current year profits

If you are an attributable taxpayer of a CFC at the end of the CFC's statutory accounting period, you may need to include the whole or a part of the profits of that period in your assessable income.

The attribution of current year profits of a CFC may be reduced if you have been subject to dividend attribution or attribution on change of residence by the CFC. Read chapter 3 and appendix 2 to see whether either of these applies to you.

This section will tell you whether you need to work out the attributable income of the CFC. A brief description of the calculation follows.

Overview of the calculation

If you are an attributable taxpayer, your assessable income may include a share of the profit, if any, from certain types of income and gains of the CFC. The profit of the CFC is called attributable income and is worked out before taking into account your share of the profit (called your attribution percentage).

You work out attributable income based on the existing rules for working out the taxable income of a resident company. However, not all of the profits of a CFC are taken into account in working out the attributable income of the CFC.

The general rule

The general rule is that only amounts that arise from certain transactions (called tainted income) which are classified as prone to tax minimisation are taken into account. These will only be taken into account if a CFC is not mainly engaged in genuine business activities, that is, where the CFC fails the active income test.

Exception for a listed country

An exception to the general rule is made for a CFC that is resident in a listed country and derives certain untaxed income or gains (of a kind specified in the Income Tax Regulations 1936) from sources outside listed countries. These amounts are taken into account whether or not the CFC passes the active income test.

Exception for trust amounts

Another exception to the general rule is for certain trust amounts derived by a CFC. These will be taken into account whether or not the CFC passes the active income test.

Exception for comparably taxed amounts

Amounts are generally only taken into account if they are not taxed in full in Australia or comparably taxed in a listed country. Amounts arising in a listed country are assumed to be comparably taxed if they do not qualify as eligible designated concession income as described in Schedule 9 of the Income Tax Regulations 1936 and in appendix 1.

Relevant period

An amount will normally only be included in your assessable income if the CFC's statutory accounting period ends in your income year.

Example 9Taxpayer with a standard year of income

A taxpayer whose income year ends on 30 June has a CFC with a statutory accounting period which also ends on 30 June. For the taxpayer's income year ending 30 June 2007, the taxpayer must include a share of the attributable income of the CFC for the statutory accounting period ending 30 June 2007.

End of example

Example 10Taxpayer who balances early

A taxpayer whose income year ends on 31 March has a CFC with a statutory accounting period ending 30 June. For the taxpayer's income year ending 31 March 2007, the taxpayer must include a share of the attributable income of the CFC for the statutory accounting period ending 30 June 2006. The CFC's attributable income for the period 1 July 2006 to 30 June 2007 would not be included in the taxpayer's assessable income until the income year ending 31 March 2008.

End of example

Special rule for companies that cease to exist

If a company that was a CFC at the beginning of its statutory accounting period ceases to exist before the end of that period, the end of the company's statutory accounting period is deemed to be immediately before it ceased to exist.

Example 11Shortened statutory accounting period when a company ceases to exist

A CFC elects a statutory accounting period that aligns with its usual accounting period of 1 January to 31 December. The company members pass a resolution to wind up the company on 1 August 2007 and it is finally de-registered on 2 November 2007 in accordance with the corporation law in the company's country of residence. As the company ceased to exist during what was its statutory accounting period, the company's statutory accounting period is taken to be from 1 January 2007 to 2 November 2007.

End of example

Conditions to be met before you work out attributable income

You only need to work out attributable income if a foreign company is a CFC at the end of the foreign company's statutory accounting period. In addition, you will only need to work it out if you are an attributable taxpayer at the end of the period.

If you have an interest in a CFC at the end of the CFC's statutory accounting period, you must work out the attributable income of the CFC for the entire period, not just for the time you held the interest.

Example 12Disposal of a CFC before the end of a statutory accounting period

A resident individual with an income year ending 30 June has a CFC with a statutory accounting period that coincides with the individual's income year. On 31 December 2006, the individual disposes of the CFC to an unassociated resident company.

In this case, the resident individual will not be an attributable taxpayer for the CFC's statutory accounting period ending 30 June 2007. As a result, the resident individual will not include in their assessable income any of the attributable income of the CFC for the period.

End of example

Example 13Acquisition of a CFC part way through a statutory accounting period

Changing the facts from the previous example so that the CFC was acquired (not disposed of) on 31 December 2006, the resident company would be an attributable taxpayer for the CFC's statutory accounting period ending 30 June 2007. As a result, the company would be taxed on the attributable income of the CFC for the entire period, even though the company owned the foreign company for only the second half of that period.

An arrangement that is designed to avoid the CFC measures by selling an interest before the end of a CFC's statutory accounting period and acquiring the interest after the end of the period will be treated as if the interest were not sold.

End of example

Were you an attributable taxpayer at the end of the CFC's statutory accounting period?

No

You do not need to work out attributable income. You do not need to continue reading this chapter.

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